Monday, June 25, 2007

How new technology developments can alter the ITES sector landscape?Are Indian Companies prepared?

Marketing management, second lecture at IIM Bangalore, professor asked me, “What is Marketing Myopia?” I was clueless. I forgot to read the Kotler last night. Hey, it was my first week at IIM. I was still not used to late night grinds. Thanks to this incident, I internalized the concept of Marketing Myopia to the extent that I started looking for Marketing Myopia in every industry’s growth statements.

What is Marketing Myopia? It is shortsightedness like when people tend to define their industry so narrowly that they are not able to see the trends which can threaten their industry. Railroad management thought that travelers want trains rather than transportation and overlooked the growing competition from airlines, buses, trucks, and automobiles. Slide rule manufactures thought that engineers wanted slide rules and overlooked the challenge of pocket calculators. There is no such thing as growth industry. There are only growth opportunities. The organizations too often are looking into a mirror when they should be looking out of the window

Take the case of Information Technology Enabled Services (ITES) industry. The euphoria surrounding that India has hit the gold mine and ITES service export will rise to US $ 100billion in near future. Further analysts are predicting that India has attained leadership in lower end ITES and its time to move up the value chain and India’s ITES service exports could cross US$ 175 billion by 2020 (Source: Nasscom) . There is talk of lack of human resources to cater to the forecasted demand but there is little realization about trends which could upset these forecasts.

Here also people are defining ITES narrowly and taking India’s leadership for granted. ITES is IT Enabled Service, not the IT Enabled Service which can be done at India. Surely ITES will rise but not necessary it will be outsourced to countries like India. The reason is development in Information technology itself. The increasing ease in use of picture with voice will threaten current trend of outsourced ITES in India. At present the people, who can speak English and learn accent by practice, can do the same work being in India as an American at New York. But imagine when using voice and picture together will be possible at affordable rates. Every one needs a face to talk to. So people making enquiry calls from US would like to see an American face or face from India or china answering their queries? Or in telemarketing calls, an Indian male face will get better response or a beautiful female face from California? So the call centers, telemarketing, customer relationship management, technical support ITES jobs are threatened in future from combining picture with voice. They will again move back to where they started from, that is their home countries.

Second technological trend is maturation of speech to text technology. As technology matures it will be common for speech to be translated into text with reliable accuracy. So the transcription services are going to be threatened. Another trend is automation in it self. Development of new applications which can automate the back processing work will reduce the requirement of human labor. So the back processing works are also threatened. Another trend is cloud computing, which should reduce the IT maintenance manpower drastically.

Time will tell how these trends unfold and how Indian companies respond to that.No doubt ITES will grow, but not ITES which Indian companies are considering. Sir, this is another example of Marketing Myopia.

Thursday, June 7, 2007

Mergers & Acquisitions (M&A) are the flavor of the season in IT & BPO industry. Right from small startups to well established big firms, the inorganic route has become one of the growth strategy. Will they be successful and create value? What are the strategic rationales for the M&A in IT & BPO industry? Are these rationales similar to rationales in other industries- economics of scale, economics of scope, synergies, capability augmentation, time to build or do we need to look them in a different way?

The understanding of these strategic rationales will have implication on valuation and due diligence process. Most of M&A’s don’t create estimated value. While much of the reason of failure is improper post merger integration but many of the expectation can be made realistic at strategic rationale itself.

IT & BPO is different from other industries. To understand what could be strategic rationale for M&A first we need to understand how growth happens in IT & BPO industry and then see what M&A drivers can help in this growth. Growth happens when company gets new projects – sounds simple. Company can get new projects either from new clients or additional work from existing clients.

In these growth scenarios the most important strategic rationales are economics of credentials and economics of relationships.

Economics of Credentials & Economics of Relationships as M&A rationale

Economics of credentials – When combining credentials of two firms, the probability to get new client increases versus the individual probabilities of getting client based on independent credential by each firm separately; we can describe this as economics of credentials.

Economics of relationships – When combining two firms, the probability of getting additional work leveraging combined client relationships increases versus the individual probabilities based on leveraging individual relationships of getting additional work by each firm separately; we can describe this as economics of relationships.

To see the relevance of economics of credentials and economics of relationships, we should look at how a company selects IT & BPO service provider? If the work is new then company typically follow through proper bid process. Information is collected from suppliers in form of RFI (Request for Information) which can sometimes run in hundreds and thousands. Based on credentials of suppliers, few of them are short listed for RFP (Request for Proposal) stage. Based on RFP response, final supplier or suppliers are selected. Here along with price and solution approach, the credentials are deeply evaluated to arrive at final selection.

Some of the credentials on which IT and BPO service providers can be evaluated or eliminated are

Financial Credentials – Revenue, Revenue in a particular industry vertical (BFSI) or a horizontal (HRO)Capability Credentials – Number of people, skill sets (number of years of experience) in technology, process, packages etc, number of people in different industry verticals or horizontalsClient Credentials – Number of Clients, Number of clients in different industry verticals or horizontals, Number of clients in particular geographyGeography Credentials – Number of delivery locations in different geographies, number of people in different geographies

If M&A helps in improving these credentials for the combined organization then organizations can leverage economics of credentials.

Sometimes companies can look for their existing suppliers for additional work. Here leveraging economics of relationships companies can win additional work. However, one caveat that relationships are starting point only. If credentials are not there, then relationships cannot be translated easily into projects. As it happened initially with many IT firms when they ventured into BPO. Company’s IT relationships didn’t automatically give them BPO clients, but once they have started getting credentials in place their relationships started fructify into client wins and their growth is much faster than their peers.

In M&A for estimating economics of relationships it will be prudent to estimate1.How many active client relationships does that company have?2.Which of these relationships one has potential to tap and grow the accounts with other services?3.Does combined firm have credentials in other services so that the opportunity can be tapped?

Some M&A examples

Companies should identify their growth areas and then look for acquisition candidates who can augment their economics of credentials and relationships in the growth area. The growth area can be a vertical, a horizontal, client geography, a delivery location. Some randomly picked recent M&A examples illustrate these points

When service providers acquire niche companies in India– Wipro acquiring Spectramind, WNS acquiring Marketics, EXL acquiring Inductis are examples of companies increasing their capability and client credentials in new services.

When service provider acquire niche companies abroad – Infosys acquiring Expert in Australia, Wipro acquiring Nervewire in US, Satyam acquiring Citisoft in Europe are examples of establishing client, geography and capability credentials and hope to leverage some of the economics of relationships

Why traditional rationales are not right measure of value?

Having looked at economics of relationships and economics of credentials it will be a good idea to see quickly why traditional rationales might not be the right measure

Economics of Scale – Does the combined average unit cost decrease by combining two firms? It generally happens in high capital intensive industry where fixed cost can be leveraged over much larger production units. In IT & BPO industry not much advantage except some advantages due to location, infrastructure, software and hardware.

Economics of Scope – Does the combined support cost like sales force can decrease by combining two firms? Not much unlike FMCG where huge sales force which can be combined and rationalized.

Time required to built and ramp up– Many of the IT and BPO firms are recruiting greater than 10000 employees in a year so this is hardly a compelling rationale for acquisition.

Talent Acquisition - There is high attrition and talent can be recruited by giving premium from market, the way many MNC’s did, so it can hardly be a compelling strategic rationale for an acquisition.

New Growth Avenue – That can happen in a saturated industry where a major growth can happen only by acquiring another major player. The IT and BPO are still sunrise industry and far from getting mature.

Lesson for Acquirers and Targets

Companies need to understand the true leverage they can get in economics of credentials and economics of relationships by acquiring. This mind set need to be in place for searching targets, due diligence, valuation and negotiation. Similarly tragets who want to get acquired should make their economics of credentials and economics of relationships proposition clear when they are selling them

But the question will always remain about the transaction value. Does the value justifies the economics company can get of credentials and relationships? If future is known, isn’t the business becomes a child play. Companies who are close to estimating real economics of credentials and relationships are more likely to be successful than others.

I will like to end this with a true conversation with an investment banker recently. He asked me “How much advantage of economics of scale will we get if we combine the two BPO firms? My answer was you can’t beyond few licenses, and infrastructure. He asked then how to estimate the synergies in merger? I said for true value you need to look economics of credentials and economics of relationships. After listening to all my explanation he asked a simple question, how will he get all this information? Well my friend, for that you are paid hefty transaction fees, isn’t it?

What Indian IT industry should be doing to remove the direct linearity between their revenues and employee numbers?

Indian IT Industry is currently at crossroads. While Industry’s top line is growing upwards of 30% year-on-year, there is a growing concern about sustainability of current business models. The main reason is the linearity between revenue growth and employee growth.

What is the way out? Remove the linearity between revenue and employee numbers. While there are talks about increasing productivity and moving up the value chain by Indian IT industry, there is very little realization that this is a huge paradigm shift. The thinking has to shift from incremental improvements to radical changes leading to multiplier growth and higher productivity.

So can a project currently executed with 100 person month effort be executed with 50 person month effort? For this to happen, Service Providers will need to get out of their comfort zone of resource based top line growth and think of innovative ways. Some of these are described below

1. Move Away from Time & Material to Fixed Price, Transaction Pricing and Managed Service Contracts – In Time & Material pricing , the price is paid on the units of effort ( person month in IT industry). To reap any real benefits of productivity Service Providers need to change the way they enter into contract with clients. In fixed price, transaction price or managed services contracts, the focus shifts from effort to time and outcome. Service Providers can significantly reduce the efforts by employing productivity tools. Since the client is concerned only about timelines and outcome this becomes a win-win scenario. But the Service Providers need to take risks here, commit to these contracts and then design innovative ways to delivering it with less manpower.

2. Improve and Automate Internal IT Processes – IT companies can also look to their internal operation and evaluate how many of these processes can be automated and how many tools can be developed to reduce the effort. Some of the examples can be automated testing, used case generator, code generator and zero defect approach.

3. Use Domain Specific Platform Approach to Software Development – Borrowing analogy from manufacturing industry, IT companies can develop platforms on which new application can be developed with little customization and minimal effort. Platform approach, if employed effectively can reduce the development and maintenance time for new applications. Progressive Service Providers can go a step further and build domain specific platforms in partnership with user organizations like banks, telcos etc. and leverage them across industry.

4. Embrace Lean Thinking - Move to Service Oriented Architecture, Software & Application Reuse - IT companies can start converting their existing software inventory into reusable block and leverage them in new development across organization. While this is happening in pockets right now at individual and project level, it need greater proliferation at organization level. The investments associated with this will far outweigh the cost of developing and maintaining it. Progressive Service Providers can go a step further and implement Service Oriented Architecture (SOA) in true spirit where entire set of applications can be reused if they are architectured using SOA standards.

5. Leverage Experience Curve to Reduce Per Unit Cost – Similar to manufacturing companies, IT companies can leverage their three decade experience to reduce per unit cost of software development. Apart from developing tools, techniques and quicker means Service Providers should leverage effective knowledge management which is beyond the current practice of document management. Learning from organization wide experience in reducing per unit cost should be the approach for progressive companies.

6. Bundling IT and BPO Services to Derive Higher Value – Bundling different services in one contract can increase average price per employee than individual contracts in different service line like IT and BPO separately.

7. Move to High Value Time & Material Services – Leading Companies can diversify to IT Consulting, Architecture Consulting, higher end Analytics which have higher billing rates compared to usual IT Development. Still at time & material contracts, this move can fetch higher revenue per employee comparing to current levels.

8. Improve Onsite/Nearshore Employee Ratio - In Time & Material, Service Providers can leverage Geographies arbitrage to increase revenue per employee. Apart from higher onsite ratio companies can diversify their workforce and develop global delivery capability including high cost locations. This can increase average billing rate and increase revenue per employee.

9. Skim the Market with New Technologies - Companies can skim the market for new technologies and skills at early stage as a regular strategy. Till the market is commoditized new skills will not be readily available in market and companies though still on time and material can command higher billing rates. Examples of this are ERP and eCommmerce skills in late 1990’s. Currently, Service Providers can leverage portfolio of new skills like RFID, Nanotechnology among others.

10. Reduce the Cost and Time to Develop New Skills by Partnering with Academics and Research Institutes - Developing skill sets in new areas can be expensive and time consuming process and can wipeout potential befefits generated by its higher billing rates. Here IT companies can partner with academic and research institutes to develop competencies in new areas on a regular basis in a cost effective way.

11. Diversify into Products – Progressive Companies can take risk and invest in developing products. Though diversification into products can be risky and would require upfront investment, this can completely delink revenue from effort and consequently from employee numbers. Coming out with new blockbuster products is not easy and in this some risk takers can think of acquiring established product companies as well.

12. Develop Productized or IP Led Services – Going forward, Service Providers can also think of leveraging services based on products or IP developed by them. The IP can be licensed and development services can be delivered on top of it. This will fetch higher revenue per employee than traditional software development work.

While some of the strategies are obvious there is interdependence across them. For example in time and material contract the benefits of code reuse will be negated. So instead of employing strategies in isolation, companies need to employee a well crafted multiplier growth strategy.

Apart from developing new competencies and employing new processes this multiplier growth strategy will require Service Providers to recruit, develop and retain different levels of talent. Proper formulation and execution of this multiplier growth strategy will separate winners from the rest of the crowd.

As clients increase their use of services globalization, many are moving from a single outsourcing vendor to a multi-vendor strategy. When implemented successfully a multi-vendor sourcing approach can help to reduce costs, lower risks and increase operational efficiency.

This white paper provides insights into the advantages of multi-sourcing and addresses the possible areas of failure as companies struggle to effectively manage an increasingly complex services globalization model. The report includes a case study of a fictional company as it transitions from a single vendor to a multi-vendor sourcing strategy

In 2004, we issued the first Offshore City Competitiveness Report, ranking twenty-seven Indian cities based on their attractiveness for offshoring. In the past two years, since the groundbreaking report was issued, multiple sourcing centers of excellence have emerged across the globe, with India home to several of the most established cities.

The Global City Competitiveness report provides enterprises a perspective on the current strengths and weaknesses of various cities in order to find a fit that meets their global sourcing requirements. For service providers looking to expand services delivery capability, the report can help identify locations of untapped labor pools and strong support infrastructure that facilitates such growth.

This report evaluates the relationship between offshore maturity and financial performance. Specifically the success metrics of creating shareholder value, improved profitability and revenue growth are addressed and the white paper also examines how globalization initiatives can make a significant contribution to these benchmarks. In the study, the Fortune 500 list is examined and categorized into levels of offshore maturity, ranging from those with little or no offshoring experience to those that have incorporated services globalization to a high degree.

Of the 500 companies analyzed, 77% of the firms have a low or medium level of offshore experience - or maturity - indicating much room left for growth for these companies to fully realize the benefits of services globalization. The report examines the maturity level by industry and how offshoring has affected each of these industries by comparing and mapping the effect of offshore maturity on shareholder value, profitability and revenue growth

As client organizations leverage services globalization to reduce costs and improve quality, they have also begun to see the potential of leveraging services globalization to reduce time-to-market. In fact, neoIT research suggests that more than half of globalizing client organizations see a reduction in time-to-market as their primary objective in services globalization.

The Time-to-Market whitepaper analyzes how leading organizations can leverage services globalization to reduce time-to-market and covers the following topics:

The importance of decreasing time-to-market.Commonly used techniques that don't work to reduce time-to-market.Process transformation as the key to reducing time-to-market.How services globalization can help client organizations transform processes and reduce time-to-market

A number of factors are converging to prompt asset management firms to leverage services globalization. The need to cut costs associated with new products and geographies, erratic equities market, globalization and increasingly demanding clients and stringent regulations mean that asset management companies must overhaul their operations, says neoIT, and leveraging services globalization optimally will be high on the list of solutions. The report also provides an in-depth view of the services best suited for globalization and actions that clients and vendors should take to benefit from Services Globalization.

You have identified a suitable offshore destination. Now what? Which Indian cities are the most attractive ITO/BPO destinations? Which Indian cities will emerge as future ITO/BPO hotspots for developing Centers of Excellence (CoE)? How critical is city classification as part of a global sourcing strategy? This study presents an India-specific City Competitive Index and analyzes the ITO/BPO attractiveness of Indian cities and future hotspots